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The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

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July 29, 2006


Minimum Wage Buzz

It seems to be a theme of the week, motivated by two, very visible, developments: A new Chicago ordinance requiring that "big-box retailers pay higher wages and benefits to workers", and the gambit by Congressional Republicans "to allow the first minimum wage increase in a decade but only if it's coupled with a cut in inheritance taxes". Maybe predictably, the reaction among the econ-types was less than positive.  Captain Capitalism had this to say:

Again, it seems the parasite has killed off its host and not realized it and in doing so has condemned itself. For while it may be grand that wages are now higher, unfortunately, this will deter companies and potential employers from conducting business in Chicago, and thus THERE WILL BE NO FREAKING JOBS, let alone ones that pay $10/hr. Furthermore, this will contribute to the divide between rich and poor in Chicago as now the only businesses that will set up shop are those that need specialized labor and would have to pay about $10/hr anyway, and thereby denied unskilled and presumably poor labor any employment prospects.

Similar sentiments are expressed by Phil Miller, by Tim Swanson, and by Ryan McMakenRussell Roberts notes that this seems to be a unique character trait among economists, a fact that Russell's blogging partner Don Boudreaux explores in some detail:

Do we know with certainty what effect raising the minimum wage will have? Maybe not. But even if we don't, that doesn't mean we can't take a position on the matter...

The evidence is indeed imprecise. Some empirical studies -- most famously one published in 1994 in the prestigious American Economic Review by David Card and Alan Krueger -- find that on at least some occasions raising the minimum wage might actually increase employment of low-skilled workers. Other studies -- for example, this 2004 one by David Neumark and Olena Nizalova -- find that the higher the real minimum wage, the worse are the employment prospects of low-skilled workers...

Basic economics tells us that the higher the cost of choosing X the less likely is X to be chosen. Economists call this relationship between cost and choice "the law of demand." Non-economists call it common sense. Does anyone really doubt that the law of demand is both true and robust? I think not -- even though persons who insist that a higher minimum wage is good for low-skilled workers carve out employer decisions on hiring workers as an inexplicable exception to this rule...

We don't know exactly how, or exactly by how much, employers as a group respond to higher minimum wages -- but the theoretical case that they do respond in ways unfavorable to low-skilled employees is too powerful to dismiss.

Greg Mankiw is skeptical that this argument will carry the day, but thinks the evidence is nonetheless on side of the minimum-wage's critics:

In the end, there is no good substitute for an appeal to facts. What the facts show is that the minimum wage is poorly targeted as an anti-poverty program. Moreover, while the evidence is controversial, some studies find significant long-term adverse effects. As a result, most economists prefer more efficient and better targeted anti-poverty tools, such as the EITC, which has grown significantly over the past few decades.

Andrew Samwick makes a similar appeal in discussing the minimum-wage/estate-tax package offered up the Republican Congressional leadership (an offer that is reviewed, without much enthusiasm, by pgl, by Mark Thoma, by Dean Baker, and by Daniel Gross.)  Says Andrew:

If you want to make sure that household heads are above poverty, then make a program directly for them and them alone. That's the EITC. Compared to the minimum wage, the EITC allows us to condition on total hours worked and family status in redistributing income. By all means, argue for its expansion if you want to help low-income heads of household...

Basically, I won't support an increase in the minimum wage until I hear the explanation of why we need a minimum wage if we have an EITC.

On the superiority of the EITC, I'm with Andrew and Greg -- and Chairman Bernanke.

P.S. Alexander Villacampa at Mises Economic Blog also highlights a proposal out of the Chicago City Council that would ban the use by restaurants of oils containing trans-fats.  (A related item from Raymond Sokolov appears on the opinion page of Thursday's Wall Street Journal.)  First smoking and foie gras, and now KFC (and other things much beloved by yours truly)?  Time to check the stuff they are using to dye that river.

July 29, 2006 in Labor Markets | Permalink

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» Minimum Wage Disaster from Economic Investigations
Macroblog sums-up the reactions of various econ. bloggers to the 2 recents events related to minimum wage laws in the US: the setting of the minimum wage for Chicago to 10 USD/hour and the proposal of US Republicans of mixing... [Read More]

Tracked on Jul 29, 2006 1:06:30 PM

Comments

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The deficiency is thinking ceteris paribus. Any policy action has multifold consequences and while focusing on the obvious is simplistic, it demonstrates lack of imagination more than anything else.

As a poverty program, the EITC makes some sense, but as a jobs program it does not. The EITC subsidizes jobs that probably shouldn't even be done in this country. Meanwhile the minimum wage promotes investment, productivity, and with the support of education and training can improve the workforce, the economy, and the country.

Posted by: Lord | July 29, 2006 at 04:13 PM

Lord -- I agree that the EITC is not a jobs program per se, but neither is the minimum wage -- in fact, I'd argue it is an anti-jobs program and I am unclear as to how it generates the benefits you suggest. Further, I'm not sure I understand how the EITC subsidizes jobs that shouldn't be done, unless you are thinking that it promotes labor force participation by those who should be doing something different. Since the EITC is really just a tax cut that lowers the tax distortion on labor supply at lower-end jobs, I think I would argue that the opposite to true. Maybe you can clarify your thinking for me?

Posted by: Dave Altig | July 30, 2006 at 09:11 AM

As to this quote:

«Basic economics tells us that the higher the cost of choosing X the less likely is X to be chosen. Economists call this relationship between cost and choice "the law of demand." Non-economists call it common sense. Does anyone really doubt that the law of demand is both true and robust?»

There is overwhelming evidence, both factual and theoretical, that the ''law of demand'' is in the general case a figment of the imagination, and even more so in the case of factor prices.

I believe that only a profoundly incompetent and dishonest economist can openly profess to ignore reswitching and the demand curve aggregation problem, which have been well known for decades.

I also reckon that the argument above depends on another standard tool of intellectual dishonesty, picturing aggregate demand and offer graphs not just as smoothly sloped curves but as lines instead of ''bands''/''ribbons'', and their meeting regions as points instead of areas within which price is indeterminate, that is, determined by negotiation power.

What I see as another display of crass prevarication and extensive intellectual dishonesty is that those who write «THERE WILL BE NO FREAKING JOBS» seem to be all too eager to show that they ignore the concept of elasticity and that even when (and it does happen) the slope of a factor demand band is smoothly downward the degree of declination matters a great deal.

The current evidence on the minimum wage story is:

* Modest increases in the minimum wage (e.g. not to $100) seem to have very little effect.

* If they have an effect it is mostly on profits, rather than employment, which rather explains why the Restaurant Association of America pays good money to lobby.

* When they have an effect on employment, a raise of 10% in in the minimum wage may result in a reduction of 1% in minimum wage employment.

Again all this applies for some region around the current level, not for order-of-magnitude increases.

Now instead of applying the intellectually dishonest attitude of a claim that many make that the sole effect of minimum wage increases is on employment, and it is large, let's look at it rationally, in the sense of looking at likely outcomes and their welfare effect.

Increasing the minimum wage by 50% may lead to 5% lower employment at the minimum wage, and by 100% to 10% lower. Do either seem bad tradeoffs? To me it seems pretty obvious that the welfare of minimum wage earners overall has increased substantially in both cases.

Posted by: Blissex | July 30, 2006 at 09:20 AM

«Economists call this relationship between cost and choice "the law of demand." Non-economists call it common sense.»

As to «common sense», perhaps some people who have got some yet are prepared to believe disingenuous mumbo jumbo on the supposed ''law of demand'' might benefit from a more realistic explanation of why not huge raises in the minimum wage affect a bit profits and not much else... What follows is a folksified discussion drawn from basic economics (as taught outside the USA perhaps :->).

There are several theories of demand and prices, depending on the type of thing being traded.

For labor, well, things are special, because factors of production have no intrinsic utility. If you pay someone to work for a day, that work by itself that adds nothing to your welfare, unless you just enjoy watching people exhert themselves. That is quite different from buying food: you need food as such; and it is different again from buying a movie DVD: watching the movie is something you enjoy directly.

People buy factors of production for only one reason, and that is profitability. If buying one extra lathe is profitable, it will be bought, if hiring an extra worker is profitable it will be hired. Unless the same money can be used to buy something even more profitable at the same level of risk.

Now look at a fast food restaurant owner: he has 10 employees, pays them each $5/h and each generates $10/h of profit, for a total of $800/shift profit with $400/shift of labor cost. Good stuff.

Now because of some reason or another he has to pay his employees $10/h, and his profit goes down to $5/h, for a total of $800/shift of labor cost, much higher than the previous $400/shift. Should he sack some of the 10 workers because his costs have gone up? Well, the owner is still making $400/shift profit, and if he sacks 1 of the 10, his profit goes down to $360/shift, so he won't. Unless he can find a way to spend the same $80/shift a worker costs him in a way that gives him a better profit than $40/h, which because of a host of reasons might not be that easy.

Also, he can increase the price of his products to recover margin, and if *all* ''restaurants'' are subject to the same increase in labor costs, that will be a lot easier, and part of the increase in the pay of workers will be borne not by the owners but by the customers.

Now of course raising wages to $20/h will have a very different effect (but not necessarily a fatal one), but the example above just shows that usually within a fairly significant band, how value added gets partitioned between profits and wages is quite arbitrary, and that as long as a worker generates enough (absolute and relative) profits employment will not be impacted. There is are some studies that show that this story happens in practice.

This is all just business «common business», and the Restaurant Association of America knows all this a lot better than many self important professors of Economics professes to show.

Hint: the Restaurant Association of America perhaps is investing quite a bit of money in lobbying to protect the jobs of restaurant employees, not the profits of restaurant owners, or perhaps not :-).

Posted by: Blissex | July 30, 2006 at 09:59 AM

Blissex, you make some good points on restaurants. However, the Chicago wage hike is targeted at large retail stores.

The population is mobile. I can choose to shop outside of Chicago if I want. I also can buy on the internet.

The increase in the minimum wage from a state mandated 6.5 bucks to a city mandated 10 bucks
seems a bit excessive. Once a government capriciously selects a small segment for wage change, where does it stop? In Chicago's case they have a pretty activist city council these days. They have banned the sale of fois gras, are getting ready to ban the use of lard and other trans fats, and even looked a microchipping dogs!

The big box stores will still build in Chicago, just in the suburbs. This will not only cost Chicago sales tax dollars, but jobs at each of the stores.

Raising the minimum wage in this case hurts the poorest people, and the most vulnerable. Because most of the stores were going to be built in the poorest neighborhoods, so the lower prices and the jobs were going where they were needed most.


Posted by: jeff | July 30, 2006 at 01:36 PM

«However, the Chicago wage hike is targeted at large retail stores.»

But large retail stores claim they already pay more than $10/h to their employees, so the Chicago wage hike is ostensibly an empty declamatory gesture, as so much ''radical'' politics is.

«The population is mobile. I can choose to shop outside of Chicago if I want. I also can buy on the internet.»

Indeed I suppose that it is even more of an empty declamatory gesture because of that.

«The increase in the minimum wage from a state mandated 6.5 bucks to a city mandated 10 bucks seems a bit excessive.»

Perhaps yes, perhaps not. Again, big box retailer claim they already pay more than $10/h and that they are not creating a lot of working poor.

Anyhow my argument was mostly about not the specific case, but the general contention that necessarily wage increases solely result in significant increases in unemployment, and that instead it depends on the details of the case.

Even if I suspect that, if the big box retailers have been honest and really pay more than a $10 wage on average, that is going to have a very modest impact anyhow.

«Once a government capriciously selects a small segment for wage change, where does it stop?»

Such a disingenuous argument, as if the government, and its sponsors, did not already work like that to their benefit.

The government picks favourites all the time, even if the favourites usually are republican sponsors who want ''protection'' from ''unfair business practices'' of one sort of another. Why do you think K-street exists if not to channel the money of republican sponsors to their legislators? ''Helping'' big business is how the USA government has been run for a very long time.

As to our contemporary times, never mind petty things like hereditary peanut monopolies, there are laws on the statute books and have been duly enacted and signed into effect, and the current administration has chosen to waste less time and money enforcing them, such as immigration law and estate tax law, thanks to the generous attentions of some important sponsors. $10/h for big box store employees is minuscule compared to that.

«The big box stores will still build in Chicago, just in the suburbs. This will not only cost Chicago sales tax dollars, but jobs at each of the stores.»

But this is just disingenuous (at best) handwaving. Where is the evidence? How much of that is going to happen? Wishful thinking, never mind imbecilities like the ''the law of demand'', does not make for a good argument.

As far as theory and experience go, in this particular case a possible and arguably likely outcome is that the profits at some big box stores will go down a bit, as average salaries go up a bit.

Posted by: Blissex | July 30, 2006 at 02:12 PM

«The big box stores will still build in Chicago, just in the suburbs.»

This statement gives as a fact that if only the minimum wage had been kept at $7.50/h then there would have built more stores in Chicago and less in the suburbs. Pure declamation, as far as it goes.

My recollection is that big box stores choose the suburbs anyhow, as this article says, for example:

http://www.slate.com/id/2104988/
«Like today's Republican Party, it focuses intensely on rural areas and generally avoids cities. (Republican conventioneers won't be able to shop at a Wal-Mart when they visit New York City.) As this Bloomberg story notes, "Sixty-seven percent of Wal-Mart's stores are in the 30 states that voted for Bush and Cheney in 2000."»

However consider the same article on CostCo:

«Pay starts at $10 an hour. About one in six employees is represented by a union, and workers receive nice health benefits.»

which suggests that CostCo is not affected by the new minimum wage (coincidence?).

Perhaps setting the minimum wage for big box employees to $10 in Chicago is note mere posturing, it is just an indirect way to make CostCo feel more welcome, and Wal*Mart less welcome. Not all big box shops have the same policies, and perhaps it is in the interest of municipalities to favour those that add better jobs.

After all someone on a rate of less than $10/hours has a fairly high chance of getting some form of welfare:

http://retailIndustry.about.com/b/a/103183.htm

Posted by: Blissex | July 30, 2006 at 05:59 PM

Raising the minimum wage tells the employer to raise the productivity of his workforce through training, raise his prices, if he can, or reduce his demand for labor by capital investment, or by shrinking. Businessmen are creative and much prefer the former solutions to the latter, all of which I find desireable as well. A rising minumum wage in this case is little different from the technological changes any business must face. The minimum wage is not an anti-jobs measure but an anti-poorjobs measure and is exquisitely targeted at underperforming industries.

If government paid all the wages of low income workers, I am sure businesses would have no trouble finding a use for them. It is just that those uses would not generally be the most productive. As it is, the EITC pays a portion of them which leads to somewhat less productive uses. It is more likely therefore to lead to poor people being locked in poor deadend jobs with little training or advancement. I am not surprised EITC has been growing as a result. I would rather we spent our taxes on education and training to raise the quality of the workforce so they could get wellpaying jobs.

The EITC is lacking even as an anti-poverty program since it doesn't address those that are unemployable or even unemployed.

France may not be the most desireable objective to strive for, but even it is more desireable than Mexico.


Posted by: Lord | July 31, 2006 at 06:50 PM

I don't think my arguments are disingenuous at all. I think that Wal-Mart has certainly shown it will put it's money where its mouth is. One butcher shop unionized, and they eliminated ALL butcher shops throughout the country. 180 of them. Now you can buy pre sliced meat at Wal-Mart in the US.

People in Chicago drive to the suburtbs for gas and cigarettes. Why won't they add a trip to Target or Wal-Mart?

Two things really concern me. Chicago has basically said it is closed for development. It chased away retailers by passing a bad law. The govt hurt the poor people in places that could really use the employment.

The other is not unfounded. Where does government control and manipulation stop? If I am Nieman-Marcus, I have to pay my window washer $10 an hour now. If I am not paying that, it increases my costs unnecessarily.

Chicago set a size of store part of the ordinance. So now, businesses will build stores to be under that size to avoid paying the higher wages, if they build at all. So what will happen...the govt will amend the law to catch the smaller retailers. Then the cycle starts again.

You guys are so blinded by partisanship that you have trouble understanding the basic economics. An activist government, using poor economic policy to try and cause social redistribution of wealth is not a good thing. I recall a tea party in Boston that started an uprising. It is a known fact that increasing the minimum wage increases unemployment, and it generally hurts the poor, the uneducated first and hardest.

BTW, recent polls have shown that 65% of Chicagoans don't like the new ordinance. Maybe we will get some new alderman-but I doubt it because the Democratic Machine is so strong here.

Posted by: Jeff | July 31, 2006 at 09:16 PM

In regards to the minimum wage increase and the issue of economists believing that it will only drive employers to deny unskilled workers, I feel I have another way to look/approach it. Well, with the expansionary fiscal policy econonmy that we're in, Govt spending is up and taxes are down, which increases pressures on prices and wages. With that, in my mind, it tends to make the standards of living greater than they were, things just cost more. And if things cost more the govt. needs to set regulations in order to help the public adjust to a higher standard of living. I realize that employers will have a thing or two to say, but hey tough its the law. If I were an employer and I had to pay my worker $7.25/hr in the future and they weren't quite to the skill that I wanted them at ok, I would take a bit of time to invest in their training and then, if they decided to leave and move on to another job in the same field at least they'd be taking knowledge with them. But this is all in a perfect world.

On to the EITC, is it just me, but the last time I checked we were trying to keep inflation and rates in check. My main concern is, if we cut taxes for a certian tax braket, while I understand it is beneficial to them, how will it affect the economy and the public? I mean if you cut taxes for one group you need to make up for it elsewhere and if the govt. had the bright idea of transferring on...well I'm sure they'll have a hell of a force to reckon with come election time. Bottom line, I say keep the wage increase and let employers and other piss and moan all they want, its a much needed change.

Posted by: short1918 | July 31, 2006 at 10:37 PM

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